What is a Notes Payable?- Definition
A note payable is a written promissory note. Under this agreement, a borrower obtains a specific amount of money from a lender and promises to pay it back with interest over a predetermined time period. The interest rate may be fixed over the life of the note, or vary in conjunction with the interest rate charged by the lender to its best customers (known as the prime rate). This differs from an account payable, where there is no promissory note, nor is there an interest rate to be paid (though a penalty may be assessed if payment is made after a designated due date).
Understanding Notes Payable
In accounting, Notes Payable is a general ledger liability account in which a company records the face amounts of the promissory notes that it has issued. The balance in Notes Payable represents the amounts that remain to be paid. Since a note payable will require the issuer/borrower to pay interest, the issuing company will have interest expense. Under the accrual method of accounting, the company will also have another liability account entitled Interest Payable. In this account the company records the interest that it has incurred but has not paid as of the end of the accounting period.
For most companies the amounts in Notes Payable and Interest Payable are reported on the balance sheet as follows:
- the amount due within one year of the balance sheet date will be a current liability
- the amount not due within one year of the balance sheet date will be a noncurrent or long-term liability
The company should also disclose pertinent information for the amounts owed on the notes. This will include the interest rates, maturity dates, collateral pledged, limitations imposed by the creditor, etc.
How are Notes Payable different from Accounts Payable?
Though both notes payable and accounts payable are similar in that they are both liability accounts, they each have their differences and serve their own unique purpose.
While notes payable is an account that details the specifics of a borrowed amount in note form, accounts payable is an account that is normally used to record liabilities in the form of purchases on credit from business suppliers. Though notes payable includes a written promise to repay what was borrowed (with interest) by a set date, accounts payable includes nothing of the sort. With no written promise, this is perhaps the biggest difference between the two accounts.
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